CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved....

31
CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/ Irwin

Transcript of CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved....

Page 1: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

CHAPTER 11

Social Security

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Page 2: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-2

Social Security Expenditures(1939-2007)

Source: Social Security Trustees [2008].

Page 3: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-3

Why Have Social Security?

• Consumption Smoothing and the Annuity Market– How Social Security works– Annuity– Consumption smoothing

• Adverse Selection and the Annuity Market– Asymmetric information– Adverse selection

Page 4: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-4

Other Justifications

• Lack of foresight and paternalism

• Moral hazard

• Economize on decision-making and administrative costs

• Income Redistribution

• Improve the Economic Status of the Aged

Page 5: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-5

Fully Funded Plan

Period 1 Period 2 Period 3 Period 4

contribute benefits

contribute benefits

contribute benefits

The GreatestGeneration

The Baby BoomGeneration

Generation X

Work Retire Dead

Unborn

Work

Work

Retire

StillDead

DeadChildhood

Childhood Retire

Each generation’s benefits based on

deposits it made during working life plus

accumulated interest

Page 6: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-6

Period 1 Period 2 Period 3 Period 4

The GreatestGeneration

The Baby BoomGeneration

Generation X

Work Retire Dead

Unborn

Work

Work

Retire

StillDead

DeadChildhood

Childhood Retire

contribute

benefits

contribute

benefits

contribute

benefits

benefits

Pay As You Go (or Unfunded) System

Each generation’s benefits come from tax

payments made by current workers

Page 7: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-7

Period 1 Period 2 Period 3 Period 4

The GreatestGeneration

The Baby BoomGeneration

Generation X

Work Retire Dead

Unborn

Work

Work

Retire

StillDead

DeadChildhood

Childhood Retire

contribute

benefits

contribute

benefits

contribute

benefits

benefits

Today’s Partially Funded System

Baby Boomers and Gen X are

also contributing to their own retirement

Page 8: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-8

Explicit Transfers

• Benefits for dependents and survivors (1939)

• Supplemental Security Income

Page 9: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-9

Benefits

• How to calculate benefits– AIME (Average Indexed Monthly Earnings) –

average monthly earnings in 35 highest paid years• Wages indexed for inflation

• Ceiling on AIME – up to tax ceiling

Page 10: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-10

Benefit Structure

If AIME < $711 PIA = .90*AIMEIf $711< AIME <$4288 PIA = .90*$711 + .32*(AIME - $711)If AIME > $4288 PIA = .90*$711 + .32*($4288-$711) + .15*(AIME - $4288)

Page 11: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-11

Adjustments

• Annual inflation adjustment

• Age at which benefit is drawn– Normal retirement age– Early retirement – benefit reduced 5/9th of one

percent a month for first 36 months preceding normal retirement age

– Late retirement – benefit increased 8% a year

Page 12: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-12

Adjustments

• Family Status

– +50% for spouse or dependent child

– If covered worker dies spouse receives 100% of worker’s benefit or spouse’s own benefit (whichever is higher)

– Divorced spouse married at least 10 years gets spouse benefit if not remarried while covered worker alive

• Earnings test and taxing benefits

– Benefits reduced $1 for every $2 earned above $14,160

– Individuals losing benefits may have later benefits increased

– Up to 85% of benefits taxed for recipients with income above a base amount ($25,000 for single and $32,000 for married taxpayers.)

Page 13: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-13

Financing

• FICA (Federal Insurance Contribution Act)

• 2008 Social Security Tax rates

– Employee

– 6.2% (OASI - 5.6%, DI - .6%) of first $102,000 of earnings on both employee and employer

– Self-employed

• 12.4%

• 2008 Medicare Tax rates

– 1.45% on both employer and employee with no earnings ceiling

• Why not fund Social Security through general tax revenues?

Page 14: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-14

Distributional Issues

• Actuarially fair return

• Intergenerational redistribution– Total benefits = Nb * B

– Total taxes = t * Nw * w

– If total benefits = total taxes:Nb * B = t * Nw * w orB = t * (Nw/Nb) * w

• Ida Mae Fuller

Page 15: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-15

Ida Mae Fuller

Page 16: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-16

Social Security Wealth:

Representative

Individuals

-1000

-800

-600

-400

-200

0

200

400

Tho

usan

ds o

f 20

06 D

olla

rs

Year Cohort Turns 65

Single Male

Low

Average

High

Max

Single Female

-1000

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Low

Average

High

Max

One-earner Couple

-1000

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65

Tho

usan

ds o

f 200

6 D

olla

rs

Low

Average

High

Max

Two-earner Couple

-800

-600

-400

-200

0

200

400

Year Cohort Turns 65T

hous

ands

of 2

006

Dol

lars

Low

Average

High

Max

Source: Updated tables, furnished by C. Eugene Steuerle and Adam Carasso, 2006.

See C. Eugene Stueuerle and Jon M. Bakija [1994] for original tables and methodology.

All values expressed in 2006 dollars.

Page 17: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-17

Other Distributional Issues

• Redistribution within a generation– Differences by earnings– Differences by lifespan– Differences by living arrangements– Differences by number of earners in the family

• Normative evaluation

Page 18: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-18

The Social Security Trust Fund

• Social Security and National Saving

• Budget Treatment of Social Security– Off budget– Unified budget

Worker RetireeTrust Fund

Page 19: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-19

Social Security and Savings Behavior

• Life-cycle theory of savings

• Wealth Substitution Effect

• Retirement Effect

• Bequest Effect

Page 20: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-20

Budget Constraint for Present and Future Consumption

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

D

I0 - S

I1 + (1+r) S

S

(1+r)S

I1 - (1+r) BF

B

(1+r)B

At endowment point consumer

neither saves nor borrows

Page 21: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-21

Utility-maximizing Choice of Present and Future Consumption

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

E1c1*

A

c0*

Saving

Page 22: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-22

Crowding out of private saving due to Social Security

Present consumption (c0)

Fut

ure

cons

umpt

ion

(c1)

N

M

I0

I1

E1c1*

A

c0*

R

T

I0T

(1+r)T

Saving before Social Security

Saving after Social

Security

Page 23: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-23

Empirical Evidence: Does Social Security Reduce Saving?

• Time-series evidence– Martin Feldstein (1974, 1996) v Leimer and

Lesnoy (1982)

• Cross-section evidence

• Evidence from other countries– Attanasio and Brugiavini (2003) and Italy

Page 24: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-24

Other ways Social Security Affects Saving

• Retirement effect

• Bequest effect

• Empirical evidence

Page 25: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-25

Distribution of Wealth

• Bequeathable vs. Annuitized Wealth

• Effect of Social Security on Bequeathable Wealth

• Effect on Wealth Mobility

Page 26: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-26

Retirement Decisions

• Social Security wealth and the retirement decision

• Empirical evidence– Diamond and Gruber [199]– Gruber and Wise [2004]

Page 27: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-27

Long-Term Stresses on Social Security

Source: Social Security Trustees [2006]

Projected revenues and projected costs of Social Security as share of Gross Domestic Product

Page 28: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-28

Long-Term Stresses on Social Security

Since: B = t * (Nw/Nb) * w

Rearrange: t = (Nw/Nb) * (B/w)

Dependency Ratio

Replacement Ratio

Page 29: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-29

Social Security Reform

• Time horizon for solvency– Sustainable solvency

Page 30: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-30

Maintain the Current System

• Raise the payroll tax

• Raise the Maximum Taxable Earnings Level

• Raise the Retirement Age

• Reducing the Cost-of-Living Adjustment

• Change the Benefit Formula

• Comparing the Options

Page 31: CHAPTER 11 Social Security Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.

11-31

Privatize the System

• Personal Accounts• Pros and cons of personal accounts

– Effect on Solvency

– Effect on Saving• Carve-out accounts

• Add-on accounts

– Risk

– Administration

– Distribution